Mittal may take cascade financing call for MTN

How do you make a little capital go a long way and, at the same time, appease both South African and Indian political sensitivities? That is the challenge Indian telecom tycoon Sunil Bharti Mittal faces pursuing MTN, the $43 billion (Rs1.8 trillion) South African telecom firm. Cascade financing seems to be his answer.

A Breakingviews analysis shows that Bharti Telecom Ltd, one of his holding companies, may need to come up with only $7.4 billion. He himself may need to come up with a fraction of that.

Mittal’s scheme seems to be to create a special acquisition vehicle with Singapore Telecommunications Ltd, his existing partner, and use judicious amounts of leverage. Details of how this would work are scarce. But it seems that the new company would effectively buy its South African rival, but leave existing shareholders with a minority stake. That would enable MTN to retain its politically sensitive Johannesburg listing, and satisfy the country’s Black Economic Empowerment programme, which requires up to a quarter of share capital be given to the nation’s black citizens.

Meanwhile, Bharti Airtel Ltd, Mittal’s Indian telecom business, would probably not be merged with MTN. That would avoid potential problems with India’s foreign investment rules, which require local telecom companies to be 74% Indian-owned. Mittal could still extract synergies from simply getting Bharti Airtel and MTN to work together. But, how will Mittal gain control for so little money?

Well, for a start, MTN could be leveraged up. It has $5.4 billion of earnings before interest, taxes, depreciation and amortization, or Ebitda, but only $1.8 billion of debt. If it raised debt to three times Ebitda, MTN could disgorge $14.3 billion in cash to its existing shareholders. Assuming a price of $43 billion, such a distribution would cut Mittal’s purchase price to $28.6 billion.

Now assume that 49% of MTN’s equity is left trading in Johannesburg. That cuts the funding Mittal’s special purpose vehicle, or SPV, needs to find to $14.6 billion. Then assume that Bharti Telecom takes 51% of the SPV—with its sugar daddy SingTel taking the rest—and its bill is cut to$7.4 billion.

The cascade doesn’t even necessarily stop there. Bharti Telecom may well be able to borrow much of the money, using its $17 billion stake in Bharti Airtel as collateral. And even if Bharti Telecom needed to raise equity, Mittal would only have to put in 70% of the capital to prevent dilution. In the end, Mittal might be able to effectively double the size of his empire for very little hard cash.